David Bach is the bestselling author of the Finish Rich series and the Automatic Millionaire series. He is a guest on The Oprah Winfrey Show, the Today Show, the Early Show, and is a columnist for Yahoo! Finance. He is best known for his common-sense strategies for living and retiring rich. His most recent book is Go Green, Live Rich, which combines the principles of living with an eco-consciousness and reaping the financial benefits.

David, you have been in the financial service business since the early '90s as a senior vice president of Morgan Stanley and author of nine books. What do you think about the current economic situation?

David Bach: As Yogi Berra once said, "It's déjà vu all over again". Markets go up and markets go down—and then they go back up again, and then they go back down. Every decade, whether it's an up or down cycle, people always believe that "this time it's different." Recently, I was at the World Finance and Economy Summit and Alan Greenspan said that what we are seeing with this global credit crisis is a once-in-a-century event. So you almost have to stop and wonder if this time it is different. I will say that I have never seen anything like this in my lifetime and most people I know who really know and understand the markets have nothing to compare this to—it's actually much worse than most people realize.

What happened—in layman's terms?

DB: It really goes like this: Once upon a time, there was a housing market that had not declined nationally for 50 years! That housing market was the U.S. housing market. And the idea, up until 2005, was that housing was safe because, nationally, houses never declined year over year. And what was even better was that people rarely lost their homes to foreclosures. So, over time, the banks said, we really don't need a down payment; houses go up in value, people don't lose their homes—so the loans are secure. Americans in turn said, "You know what, I have all this equity in my house now because it's gone up so much in value so why don't I pull this money out and go buy some stuff?"

What's ironic is that we went out and bought lots of stuff from abroad (China, India, gas from the Middle East) and we made all these other countries rich. They in turn needed to do something with the money so they invested back in our bonds (our loans on our homes). That allowed the lenders to keep selling more mortgages and people to keep buying bigger homes and more homes (which also created more equity in our homes) which we then pulled out and used to buy more stuff from abroad. And the cycle continued—until late 2005 to 2006, when the cracks started to show.

Beginning about two years ago, housing prices stopped going up—and then they started coming down. Millions of people had zero equity in their homes because they had pulled it out to buy stuff—and they started walking away from their houses. But not everyone is losing their homes today because they pulled their equity out. Many people bought homes with bad mortgages and now can't afford them.

In essence, what happened is we lived off our homes as though they were piggy banks instead of treating our homes like the ultimate security blanket. Now our piggy bank is empty and so we have to save money again before we can buy more stuff. And with the current credit crisis we can't borrow money to buy stuff—so we really need to save money. And to save money we have to spend less. And that, my friends, is called a recession. And because our piggy banks are so empty, it is going to take at least a few years to fill them back up to go buy more stuff.

Are we in a recession?

DB: I've been saying we are in a recession since last year. Technically, we may not yet be a recession—but at this point basically everyone accepts that we are. People are spending less money, and that creates a recession. It's incredibly simple. First you watch your friend lose his job and you think, "Bob just lost his job, poor guy. Maybe we should spend less." You spend a little less, and you talk a lot about poor Bob. Then your buddy Mike loses his job, and you say, "Poor Mike. Maybe we should spend a little less." Again you talk about poor Mike and maybe spend a little less. Then you lose your job and you don't have money to spend, but you have credit cards to use—so you spend a little less. Then your credit cards become maxed out and you are broke and you really spend less. This last part of the cycle is just starting to hit. We haven't yet really seen Americans dramatically cut back on their spending, but we are about to see that happen—and it will be the biggest decline in spending during the holidays in probably a decade. The real question is how long will we spend less, and how dramatically will we cut back.

My prediction is that we are not even at the mid point of this recession yet, because the average American has not yet truly slammed on the spending brakes. I was at Toys R Us the other day with my son Jack and we wanted to buy a new game for our Wii. The line was literally 25 deep, and after 15 minutes with a five-year-old, I put down $150 worth of video games and decided instead to buy them later. The entire line of people was holding stacks of these games—and again it was 25 people deep, so I'm not seeing a cut-back in spending yet. The stores in Manhattan are mobbed, the restaurants are packed, and the bars are standing room only. In terms of spending, we're still at the party—having our last "round" before the bar closes. I think next year is when we will really start to see people cutting back on their purchases and going through the ultimate hangover from all of our over-spending.

Copyright © 2008 by David Bach. All rights reserved.